Beyond Ordinary Interest: Why Tax Authorities Cannot Tax Section 28 Land Compensation Awards
How the ITAT Rajkot Bench Protected Landowners from Double Taxation on Compulsory Agricultural Land Acquisition
Navigating the Legal Fault Lines Between Statutory Accretions and Income from Other Sources
By Legal Editor
New Delhi: September 18, 2026:
When the state exercises its sovereign power of eminent domain to acquire private land for public infrastructure, industrial corridors, or urban expansion, the process is rarely swift or frictionless. Landowners frequently find themselves locked in protracted legal battles spanning years, or even decades, to secure fair and equitable compensation for their ancestral properties. When courts eventually intervene to rectify undervalued awards by granting enhanced compensation along with statutory interest, a secondary, equally bruising battle frequently begins—this time with the Income Tax Department.
For years, tax authorities across India have routinely classified the interest component received on enhanced compensation as taxable "Income from Other Sources" under Section 56(2)(viii) of the Income Tax Act, 1961. This bureaucratic practice often results in a harsh paradox: farmers and rural landowners, whose primary capital assets (agricultural land) enjoy statutory exemptions under Section 10(37) of the Income Tax Act, find themselves facing steep tax demands on payouts that are intrinsically tied to the value of the land itself.
However, a landmark ruling by the Income Tax Appellate Tribunal (ITAT), Rajkot Bench, in the case of Kishorbhai Nathabhai Makani for Assessment Year 2016-17, has reinforced a critical protective shield for taxpayers. The tribunal emphatically held that interest awarded under Section 28 of the Land Acquisition Act, 1894, is not ordinary commercial interest or independent revenue. Instead, it constitutes an inherent accretion to the value of the land, forms an organic part of the enhanced compensation, and qualifies entirely for tax exemption under Section 10(37) of the Income Tax Act. This analytical piece delves deep into the statutory mechanics, landmark judicial precedents, and overarching legal implications of this vital ruling.
Anatomy of the Dispute: Section 28 vs. Section 34 of the Land Acquisition Act, 1894
To comprehend why interest on land acquisition compensation sparks such intense litigation, one must examine the foundational statute governing these proceedings: the Land Acquisition Act, 1894 (and its modern successor principles). Within this framework, the legislature deliberately drew a sharp legal distinction between two types of interest awarded to dispossessed landowners: Section 28 interest and Section 34 interest.
The Nature of Section 28 Interest
Section 28 of the Land Acquisition Act empowers the court hearing a reference against the Collector’s initial award to order the collector to pay interest on the excess amount of compensation determined over and above what was originally awarded.
Discretionary yet Statutory: The award of Section 28 interest is within the court’s discretion, but it is strictly tied to the enhancement of the property’s value.
Character of Compensation: As established by authoritative judicial pronouncements, Section 28 interest is not compensation for the use of money, but rather compensation for the deprivation of land. Because the enhanced compensation reflects the true, fair market value of the property at the time of notification, any interest awarded under Section 28 represents the time-lagged realization of that enhanced value. It travels with the compensation, absorbing its character.
The Nature of Section 34 Interest
Conversely, Section 34 deals with interest payable for delays in making payment after the compensation has already been formally determined and finalized. If the acquiring authority fails to deposit or pay the compensation amount awarded by the collector within the stipulated statutory period, Section 34 interest kicks in as a penalty or compensatory payment for delayed disbursement.
Unlike Section 28, Section 34 interest is purely compensatory for the delayed availability of funds post-determination.
Consequently, tax jurisprudence generally treats Section 34 interest as independent income, taxable under the head "Income from Other Sources," because it does not form an accretion to the capital value of the acquired land itself.
The failure or refusal of assessing officers to recognize this crucial dichotomy has historically led to widespread administrative overreach, where Section 28 interest is lumped together with Section 34 interest and subjected to aggressive taxation.
The Statutory Framework under the Income Tax Act
The intersection between land acquisition payouts and tax liabilities involves a delicate interplay of several key provisions within the Income Tax Act, 1961. Understanding these provisions clarifies the precise legal battlefield upon which cases like Kishorbhai Nathabhai Makani are fought.
Section 10(37): The Shield for Agricultural Land
Section 10(37) of the Income Tax Act provides a specific, unconditional exemption from capital gains tax in respect of any capital gain arising to an individual or a Hindu Undivided Family (HUF) from the transfer of agricultural land. To qualify for this exemption, certain conditions must be met:
The land must be urban agricultural land that was subject to compulsory acquisition under any law, or its consideration must be determined or approved by the Central Government or the Reserve Bank of India.
The land must have been used for agricultural purposes by the assessee (or their parents) for at least two years prior to the transfer.
The income arising from such compulsory acquisition must be received by way of compensation or enhanced compensation.
Because Section 28 interest is judicially recognized as an inseparable component of enhanced compensation, it naturally inherits the tax-exempt status of the underlying capital receipt under Section 10(37).
Section 56(2)(viii) and Section 145A: The Revenue's Weapon
The Income Tax Department frequently attempts to tax land acquisition interest by invoking Section 56(2)(viii) (read with clause (iv) of Section 56), which mandates that income by way of interest received on compensation or enhanced compensation referred to in sub-section (1) of Section 45 shall be assessed as "Income from Other Sources."
Furthermore, Section 145A (and subsequent amendments introducing Section 145B) dictates that income by way of interest received on compensation or enhanced compensation shall be deemed to be income of the year in which it is received.
Tax authorities often read these provisions in isolation, arguing that any receipt labelled as "interest" automatically falls under the tax net of Section 56, regardless of its statutory origin under the Land Acquisition Act. The judiciary, however, has consistently rebuffed this mechanical approach, ruling that nomenclature must yield to true legal character.
Judicial Precedents and Jurisdictional Binding Authority
The legal foundation underpinning the ITAT Rajkot decision is not a novel invention; rather, it represents the culmination of a robust line of binding judicial precedents established by the Hon'ble Supreme Court of India and jurisdictional High Courts.
The Apex Court's Ruling in Ghanshyam (HUF)
A foundational milestone in this jurisprudential evolution was the Supreme Court’s landmark judgment in Commissioner of Income Tax, Faridabad v. Ghanshyam (HUF). The Supreme Court meticulously analyzed the scheme of the Land Acquisition Act and drew a bright-line distinction between interest awarded under Section 28 and Section 34.
The Apex Court held that interest under Section 28 is an accretion to the value of the land and forms an integral part of the enhanced compensation. Because it forms part of the compensation under Section 45(5)(b) of the Income Tax Act, it cannot be arbitrarily severed and characterized as ordinary interest income under Section 56.
The Gujarat High Court Precedent: Movaliya Bhikhubhai Balabhai
For taxpayers within the state of Gujarat, the definitive word came from the jurisdictional High Court in Movaliya Bhikhubhai Balabhai vs. ITO. In this landmark ruling, the Gujarat High Court explicitly examined the impact of legislative amendments introducing Section 145A and Section 56(2)(viii).
The High Court held that despite these amendments, interest awarded under Section 28 of the Land Acquisition Act does not lose its character as compensation. It does not fall within the true meaning of taxable "interest" contemplated under the Income Tax Act provisions, and consequently, tax deduction at source (TDS) under Section 194A cannot be sustained on such amounts.
In the Kishorbhai Nathabhai Makani case, the ITAT Rajkot Bench rightly emphasized that as a quasi-judicial body operating under the territorial jurisdiction of the Gujarat High Court, it is bound by the doctrine of stare decisis to follow the Gujarat High Court's ruling. The tribunal rejected the Revenue’s reliance on contrary views from non-jurisdictional forums—such as the Punjab and Haryana High Court’s ruling in Manjeet Singh (HUF)—reaffirming that local judicial hierarchy and binding precedents must prevail.
The Facts and Findings in Kishorbhai Nathabhai Makani
To appreciate the practical application of these legal principles, it is instructive to examine the specific factual matrix of the Rajkot tribunal's recent ruling.
The Transaction and Assessment History
The Payout: The assessee, Kishorbhai Nathabhai Makani, received a 25% co-owner share of enhanced compensation totalling ₹2.69 crore for the compulsory acquisition of ancestral agricultural land. Within this lump sum, ₹1.89 crore represented statutory interest awarded under Section 28 of the Land Acquisition Act.
The Assessing Officer's Stance: Initially, the Assessing Officer (AO) reviewed the transaction and correctly concluded that the Section 28 interest formed an intrinsic part of the full consideration for the compulsory acquisition of agricultural land, thus escaping taxation under "Income from Other Sources."
The Revisionary Proceedings: Subsequently, the Principal Commissioner of Income Tax invoked revisionary powers under Section 263 of the Income Tax Act, arguing that the AO’s order was erroneous and prejudicial to the interests of the Revenue. The National Faceless Appeal Centre (NFAC) initially upheld the taxability of the interest component.
The Tribunal's Verdict: Upon further appeal, the ITAT Rajkot Bench quashed the revisionary proceedings. The tribunal observed that the AO had conducted proper inquiries and adopted a legally plausible view anchored squarely in binding jurisdictional precedents. Furthermore, the tribunal noted that taxing the exact same compensation and interest amounts again in the hands of a co-owner would result in impermissible double taxation, as the primary amounts had already been subjected to scrutiny and taxation elsewhere in the ownership chain.
Comprehensive FAQ in a Searchable Index Format
To assist taxpayers, legal practitioners, and financial consultants in quickly navigating these complex legal points, the following searchable index format addresses the most critical questions arising from the ITAT Rajkot ruling.
1. What is the core ruling of the ITAT Rajkot Bench regarding land compensation interest?
Summary: The tribunal ruled that interest awarded under Section 28 of the Land Acquisition Act, 1894, on enhanced compensation for compulsory acquisition of agricultural land is not ordinary interest. It represents an accretion to the value of the land, forms part of the compensation, and qualifies for complete tax exemption under Section 10(37) of the Income Tax Act.
2. How does Section 28 interest differ from Section 34 interest under the Land Acquisition Act?
Summary: Section 28 interest is awarded by a court on excess compensation as an accretion to the property's value, sharing the tax-exempt character of the land compensation. Section 34 interest is awarded strictly for post-determination delays in payment and is treated as taxable income under "Income from Other Sources".
3. Can tax authorities tax Section 28 interest under Section 56(2)(viii)?
Summary: No, provided the underlying land is agricultural land exempt under Section 10(37). While Section 56(2)(viii) taxes general interest on compensation, binding judicial precedents establish that Section 28 interest retains the character of capital compensation rather than standard interest income.
4. Are tax authorities bound by jurisdictional High Court rulings?
Summary: Yes. Under the doctrine of stare decisis, subordinate tax authorities and tribunals within a specific state (such as Gujarat) are strictly bound by the decisions of their jurisdictional High Court (e.g., Movaliya Bhikhubhai Balabhai vs. ITO). They cannot bypass binding local precedents by citing contrary rulings from non-jurisdictional High Courts.
5. What constitutes agricultural land exemption under Section 10(37)?
Summary: Section 10(37) exempts capital gains arising to individuals or HUFs from the compulsory acquisition of urban agricultural land, provided the land was used for agricultural purposes for at least two years prior to acquisition by a government authority.
6. Can the Principal Commissioner use Section 263 to overturn an Assessing Officer’s legally plausible view?
Summary: No. Revisionary proceedings under Section 263 cannot be invoked merely because the Commissioner prefers an alternative view, provided the Assessing Officer made adequate inquiries and adopted a view that is legally tenable and supported by binding judicial precedents.
Conclusion
The ITAT Rajkot Bench ruling in Kishorbhai Nathabhai Makani serves as a powerful judicial reminder that statutory nomenclature must never override true legal substance. For rural landowners and farmers who have parted with their ancestral agricultural lands under compulsory government acquisition, Section 28 interest is neither a windfall financial investment nor commercial interest income—it is the rightful, delayed realization of the land's true economic value. By shielding such receipts from unwarranted double taxation and arbitrary reclassification, this decision reinforces the rule of law, respects judicial hierarchy, and protects vulnerable taxpayers from administrative overreach.